Tax cuts will boost economy

OPINION:

As Republicans balance competing interests to craft a tax cut, both Democrats and the Trump administration are making outrageous claims.

The Tax Policy Center (TPC), headed by a former Obama administration official, estimates the Republican tax plan would slash federal revenue by $2.4 trillion and harm working families, while Secretary Munchin and White House Chief Economist Kevin Hassett claim the tax plan will pay for itself by boosting GDP growth to 2.9 percent and household incomes by $4000 to $9000 a year.

The TPC makes lots of assumptions about details of the final bill that have yet to be specified. The House and Senate drafts of the Budget Resolution specify tax cuts will either be financed with spending cuts or add no more than $1.5 trillion to the deficit over 10 years. The latter target will likely define the final bill.

Left-leaning think tanks are engaging in polemics to provide ammunition for Democrats in Congress and grab some headlines. We won’t know the impacts on particular groups until precise details of the package emerge.

As for the administrations claims, economists estimate the growth effects from cutting taxes from two angles. Tax cuts put more money in consumers’ hands and thereby boost demand and spending immediately. And lower tax rates on profits encourage more investment that raises labor productivity and long term growth — the so-called dynamic effects.

A $150 billion annual tax cut allocated equally between corporate and personal tax cuts would increase the demand for goods and services by nearly that amount, and yet again with diminishing effects as workers and businesses spend the additional wages and profits from making those products.

Generously speaking, this Keynesian multiplier effect is no more than 1.5. We should expect a one-time boost to GDP of no more than $275 billion and $20 to 40 billion in new tax revenues. However, those estimates do not consider dynamic gains from encouraging more investment and permanently higher GDP growth.

Other industrialized countries have been shifting tax burdens from businesses to individuals by leaning heavily on personal income and value added taxes while slicing corporate rates. European families may get inexpensive health care and higher education, but they pay for those with higher taxes than their American counterparts.

Tax experts estimate U.S. effective corporate tax rates are substantially higher than elsewhere. Cutting the U.S. corporate burden by $75 billion would reduce the federal take by 20 percent.

According to estimates compiled by Mr. Hassett and R. Glenn Hubbard, that should boost corporate investment by 10 to 20 percent and in the current environment of deregulation, it seems likely the overall benefit would be in the upper half of that range.

If the Congress approves as expected a special personal income tax rate, which apply to most small businesses, a 20 percent increase in private investment overall could have significant consequences for labor productivity.

The economy is near full employment and with states raising minimum wages, business can be expected to devote most of the new investment to boosting labor productivity through robotics, computer software, worker training and better scheduling of work time rather than by adding to head count.

Workers would gain principally through opportunities to move to better jobs, greater bargaining power and consequently higher wages but raising pay 7 to 15 percent as the President’s Council on Economic Advisors claims is a rather broad leap considering the expected jolt to GDP growth.

During the recent recovery, labor productivity has advanced about 1.0 percent a year, and it seems reasonable to say that a 20 percent business tax cut would boost labor productivity and economic growth by about 0.2 percentage points.

During the recovery from the financial crisis, annual GDP growth has averaged about 2.2 percent growth, and the Trump tax cuts could optimistically be expected to permanently raise that to 2.4 percent.

Overall the combined Keynesian and dynamic growth effects would boost tax revenues by $65 to $85 billion.

Those estimates are hardly in line with the administration’s assertions or big enough to support the claim that tax cuts would finance themselves.

Until Congress attacks disincentives to work created by the massive increase in entitlements — easy access to social security disabilities, Medicaid and food stamps for adults who refuse to work and the like — labor markets will remain tight and economic growth will be below the pace of the closing decades of the 20th century.

• Peter Morici is an economist and business professor at the University of Maryland, and a national columnist.